Transocean Q1 Earnings: Watching Cost-Cutting And Shift To Ultra-Deepwater Updates

| About: Transocean Ltd. (RIG)

Transocean (NYSE:RIG) is expected to release its Q1 2013 results on May 8, reporting on a rather eventful quarter that saw it reach a $1.4 billion agreement with the U.S. Department of Justice to settle charges relating to the Macondo well incident. During the quarter, the firm also came under attack from activist investor Carl Icahn, who has been pushing for a shakeup of the company's board of directors and also for an increase in dividends. On the operational front, however, we expect things to have continued quite smoothly through the quarter as demand for deepwater drilling remained strong, although some maintenance-related delays in the U.S. Gulf of Mexico could temporarily impact results.

During Q4 2012, revenues grew by 8% year over year to around $2.3 billion, while net income was around $456 million compared to a loss in the previous year, aided by stronger drilling in the U.S. Gulf of Mexico and better fleet utilization rates. Here are some of the recent developments that we believe could impact quarterly earnings and Transocean's stock going forward.

Gulf of Mexico Will Remain Important, but Revenue Efficiency Could Slow Temporarily

Strong demand for offshore drilling has helped Transocean boost utilization rates of its entire fleet. Utilization rates are a measure of how many rigs are working on contracts in comparison to total fleet size. Over 2012, rates improved by around 9% to 78%, and we expect them to have remained strong through Q1 as well. Through the first quarter, the firm reported contract additions and extensions valued at around $765 million.

However, revenue efficiency -- which is a measure of how much each active rig earns while it is contracted -- could be impacted slightly due to some maintenance-related issues on some of the firm's deepwater rigs in the U.S. Gulf of Mexico. The Gulf happens to be Transocean's most important geographic market since almost half of the firm's fleet of ultra-deepwater rigs are contracted here. These delays are likely to reduce revenue efficiency to below the 93% level it was at in the last year. Since the firm's ultra-deepwater rigs typically command the highest day rates among its fleet (average $500,000 per day), this could impact Transocean's quarterly revenues.

Cost Reduction Initiatives Under Way

Transocean divested its fleet of 38 low-specification rigs during Q4 of last year, choosing to focus on ultra-deepwater and high- specification rigs. Now the firm intends to downsize its shore-based support infrastructure to account for its smaller overall rig count. The cost reductions will encompass a streamlining and consolidation of some business functions, as well as an elimination of some non-core operations. The firm anticipates that these initiatives would help to achieve annualized savings of around $300 million beginning in 2014, and this could significantly improve margins going forward. Besides getting more details on these cost reduction plans, we will also be watching the company's plans for controlling the costs of its offshore operations.

We have a price estimate of $55 for Transocean, which represents a 7% premium to the current market price.

Disclosure: No positions.